Closed-End Income with Options

02/18/2014 9:00 am EST

Focus: FUNDS

Robert Carlson

Editor, Retirement Watch

This closed-end fund, which is a member of our Sector Portfolio and our Balanced Portfolio, owns many of the largest global companies; it then writes call options against many of these stock positions, explains Bob Carlson in Retirement Watch.

This recommended fund is Eaton Vance Tax-Managed Diversified Equity Income (ETY). The options that the fund writes give buyers the right to buy the stocks from the fund at fixed prices by a certain date.

If a stock doesn't exceed the option price by the expiration date, there's no advantage for the option holder to buy the stock. The option expires worthless, and the fund keeps the premium it earned from writing the option.

If the stock rises above the option price, the option holder buys the stock for the option price. This costs the fund some capital gains it otherwise might have earned.

The option writing, plus owning, primarily, the world's largest companies, give the fund's net asset value more stability than other funds. Option writing also increases the fund's income, allowing it to increase distributions.

The share price of this closed-end is up 23% over the last year. But the net asset value of the fund didn't increase as much, cutting the fund's discount to its net asset value to around 10.56%, which is very close to its average discount.

The fund has a high yield—a distribution rate of over 9% recently. It has a history of making “return of capital” distributions. It adopted a policy of limiting these and had no such distributions in 2012, and probably only a limited amount for 2013. It doesn't use leverage.

The fund's stock holdings are about 80% US and 20% international. Top holdings recently were Google, Apple, Amazon, Gilead Science, and Occidental Petroleum.

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